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The swap scheme that led to a forty-fold increase in one woman's TFSA

By the end of 2009, one taxpayer’s initial TFSA contribution of $5,000 was worth $205,795 thanks to swap transactions.
Photo: Brent Lewin/Bloomberg

Jamie Golombek

Published: November 30, 2018 - 1:44 PM

Our beloved TFSA will soon celebrate its tenth anniversary with an increase in the annual dollar limit to $6,000, beginning Jan. 1, 2019. While most of us simply use our TFSA to save for retirement or, perhaps for shorter-term goals such as a down payment on a home, the opportunity for abuse of the tax-free nature of the TFSA has been there from Day One.

Over the past decade, the government has introduced a variety of anti-avoidance rules meant to stop taxpayers from enjoying an inappropriate “advantage” from their TFSAs. On Oct. 1, the Canada Revenue Agency published an extensive Folio going through what’s known as the “advantage rules” for registered plans and providing examples of how the anti-avoidance rules work.

If you fall afoul of the rules, you can face a 100 per cent penalty tax on the fair market value of any advantage you receive that is related to a registered plan. Earlier this year, a taxpayer attempted to challenge the constitutionality of the advantage tax, characterizing the 100 per cent tax rate as “a confiscation of property.” Not surprisingly, that argument failed, with the court finding that the 100 per cent advantage tax “fell within a valid TFSA scheme of taxation within a valid (Tax Act).”

One of the situations that could lead to the 100 per cent penalty tax involves what are known as “swap transactions” in which investments (typically, securities or cash) are transferred between the TFSA and its owner, regardless of whether such the swap was done at fair market value. As the CRA states in its Folio, “the advantage tax will nonetheless apply in respect of any future increases in the total FMV of the property held in connection with the plan that are reasonably attributable, directly or indirectly, to the swap transaction.”

While swap transactions were not originally part of the TFSA advantage rules, legislative amendments were introduced on Oct. 17, 2009, a mere ten months after the introduction of the TFSA, in response to stories that some savvy Canadians had already built up six-figure TFSAs via opportunistically swapping of securities back and forth among their accounts.

How, exactly, did they do it? Thanks to a new Tax Court decision just released last week, we have some fresh insight as to the type of swap behaviour that may have led to the effective fall 2009 shutdown of swap transactions.

The case involved a B.C. taxpayer, “a sophisticated investor with extensive knowledge of the stock market … (who) proved to be highly knowledgeable about her trading activities.”

The taxpayer had three accounts with her discount brokerage: a non-registered direct trading account, a self-directed RRSP and a self-directed TFSA. From May 15 to Oct. 17, 2009, the taxpayer engaged in 71 swap transactions. The swaps involved transferring listed shares between her TFSA and her non-registered and RRSP accounts.

The taxpayer explained that each swap transaction required that the assets swapped be of equal value. Her brokerage’s swap valuation rules stated that if the stock she was swapping had traded that day, she could select “any price between the high and low of the day.” The taxpayer acknowledged “that, in following these guidelines, she was at liberty to pick the price of the day that would be most advantageous to her when swapping in or swapping out shares.”

For all of the swap transactions, the price selected for the shares swapped out of her TFSA was the highest price at which they had traded during the day up to the time of the swap. Conversely, for the shares swapped into her TFSA, the price chosen was the lowest at which they had traded.

By the end of 2009, the taxpayer’s initial TFSA contribution of $5,000 was worth $205,795. For the years 2010 and 2012, the increase in FMV was $70,841 and $29,217 respectively. (Her TFSA decreased in value in 2011.)

The issue in the case was whether the taxpayer was liable to pay the 100 per cent advantage tax for the 2009, 2010, and 2012 taxation years, in relation to the increase in the total fair market value of the property held in her TFSA resulting from her swap activity.

While a swap was not specifically an “advantage” prior to Oct. 17, 2009, an advantage included “an increase in the total fair market value of the property held in … the TFSA if it is reasonable to consider … that the increase is attributable, directly or indirectly, to a transaction or … series of transactions … that would not have occurred in an open market in which parties deal with each other at arm’s length and act prudently, knowledgeably and willingly, and … as one of its main purposes to enable a person … to benefit from the exemption from tax … in respect of the TFSA.”

The taxpayer argued that there was no advantage as the parties to the swap transactions dealt at arm’s length, the swap transactions were priced at FMV and thus would have occurred in an open market. She also argued that benefiting from the tax-free status of the TFSA was not one of the main purposes of the swap transactions and that the swap transactions did not qualify as a “series of transactions” because they were not preordained.

The CRA’s view was that the taxpayer’s swap transactions met the requirements under the Tax Act’s definition of advantage (above) and the further increases in value of the shares in 2010 and 2012 also constituted an advantage.

The judge concluded that the advantage tax, amounting to $200,795, did apply in 2009 as “the taxpayer was able to shift value from her RRSP and (non-registered account) to her TFSA by selecting the price of the swapped shares a posteriori. Because these trades took place off-market and because parties dealing at arm’s length would not have agreed to set prices that would constantly disadvantage the holders of the RRSP and (the non-registered account.)”

The judge, however, felt that the increase in the value of the shares in 2010 and 2012 was attributable to what happened in the market and was therefore “neither a direct nor an indirect consequence of the swap transactions,” and thus the advantage tax was not applicable in those years.